NFTs Are Probably Not Beanie Babies
I’m new enough to the world of NFTs—and that world is shifting so rapidly—that I’m certain my authority over the subject is woefully inadequate. But as the consumer-facing nature of the blockchain is also only recently beginning to bloom, I’d say it doesn’t take much yet to get a reasonable education. With that in mind, the following is my take on why NFTs may represent a more fundamental economic shift than what I had originally imagined them to be.
NFTs: Beanie Babies of the Future
Or, at least, that’s where I started. At first blush and through the nuance-crushing filter of typical media reporting, the idea seems like nothing more than digital ownership of an “asset” with no marginal cost of replication. And that sounds insane. Pictures of apes are trading for tens of thousands of dollars, and the most charitable notion I could come up with was that this is a phenomenon likely to appeal only to the intersection of “collectors” and “technophile early-adopters.”
And anecdotally, that bit still seems to be true. That friend of yours who spends too much money on speculative nonsense obviously bought a Topps baseball highlight NFT for thousands of dollars because, like, they’re gaining so much value! And somewhere in the back of your mind, some recollection of Beanie Babies and tulip bulbs are throwing off warning signs.
Why do you need your baseball card on the blockchain? And why would you want to “own” something digital like a sports highlight? I mean, I can see it online just as easily as you can.
The Stock Market for Everything
Then again, though, there are some fundamental mechanisms at play here that, regardless of this particular implementation, may actually become pretty ground-breaking. NFTs are just another implementation of the distributed ledger system, but rather than tracking ownership of “currency” like Bitcoin or Ethereum (which can be used to buy things, at least in theory), NFTs track ownership of something more abstract: anything at all.
As it turns out, “fractional ownership” akin to the stock market is maybe a better analogy than digital Beanie Babies. Combined with smart contracts to, say, pay out dividends according to ownership, NFTs may replicate (and multiply) the individualized access to the stock market that Robinhood’s arrival on the scene had. But in this case, we’re securitizing not companies but … well, just kind of anything at all.
Art
For example, suppose you’re an art lover, or else suppose that you just want to cash in on the massive relative growth rate art investing allows for those who can afford to get into it. But suppose that you don’t have the means to fork over a small fortune to get started. Enter: Masterworks. They’ll “mint” this Banksy and let you buy an NFT representing a fraction. The NFT (in this case, backed by a real-life piece of art rather than a digital copy) appreciates as the value of the piece appreciates.
(For a stranger example, RTFKT started out doing something similar for sneaker collectors until they realized their users would be happy to fractionally own digital sneakers rather than the sneakers themselves. This is still bizarre to me, but Nike seemed to think it was worth $300 million or so.)
Fractional Ownership and Dividends
This is a more fun example, in my opinion. A musical artist who writes and records a song can mint an NFT of their song. But rather than treat it as a collectible, suppose they treat it as we do stock in a company: they retain ownership over some fraction, then set the remainder up for sale with the expectation that any proceeds from the song in advertisements, movies, or television pay dividends out to other fractional owners.
This does something particularly interesting to incentives: people who believe the song will catch on are incentivized to buy in; and people who buy in are incentivized to ensure it catches on by sharing it. The old world of tight-knit network-driven record studios is replaced (at first and in this optimistic hypothetical, at least) with something more grassroots and distributed.
There’s no reason to restrict that structure to music, of course.
Trustlessness and (Anti-)Regulation
Between this future vision of NFTs and the stock market are two main differences: (a) trust-less decentralization and (b) regulatory framework, and the two are highly interrelated. Each distributed ledger system sits on one of a few decentralized, “trust-less” algorithms that have all kinds of depths and pros and cons, but each with decentralization as a primary characteristic. And because what we’re talking about is ownership of an “asset” rather than something as well understood as a company, it can be difficult to know who and how to regulate.
Betting
The word “regulatory” appears 73 times in Draftkings 10-K filing with the SEC, and every mention has risk in mind. If federal or state regulators don’t like what they’re up to, there are real monetary consequences.
But suppose DraftKingsNFT were an app conceived, coded, NFT-ized, and distributed on the blockchain? Someone built DraftKingsNFT, but rather than recognize the proceeds under some well-known and well-trodden corporate structure, they just took a big chunk of the initial NFT or crypto offering. Now it’s out there in the world, unmanaged, and super popular. Who does the US target for regulation if the app development wasn’t illegal? Tough to know who to go after.
(Choose your favorite recently-popular-and-newly-regulated app and run the thought experiment through—especially those that seem to create enterprise value by bending ever so slightly around existing labor laws like Uber and Lyft. This idea is at the heart of Decentralized Autonomous Organizations.)
Responsibility for regulation is also pretty underspecified, at least in the US.
Taxation
Thus far it seems that NFTs, like cryptocurrencies, will be taxed as assets via capital gains. That sets a pretty interesting set of incentives out, too: rather than pay employees to be taxed under ordinary income, perhaps a savvy employer grants and repurchases NFTs. Or maybe options end up on the blockchain as a way to lower the bar to constructing employee incentive programs. There’s already a fairly healthy secondary market for fractional ownership in private companies, but a one-click option could lower the bar for participation pretty dramatically.
Distributed Government?
In fact—and now we’re really getting into speculative territory—any number of the functions of government might find themselves on the distributed ledger, particularly those that don’t require geographic collocation or resemble insurance. As far as I can tell, smart contracts are not yet that smart; but it’s only a matter of time before some of the more complex dealings become codified and distributed. The speed of interaction alone is enough of an incentive to create a multitude of micro-contracts once they meet a threshold of sophistication and low bound for risk, and the challenges of regulation and enforcement could be a multiplier.
Implications
NFTs’ arrival is almost certain to herald some new wave of democratized securities that will make even the most abstract nonsense tradable. That’s probably great news if you’re an artist or an entrepreneur as the wave introduces new complexities and opportunities for market efficiencies to appear, at which point we should expect some level of fracturing and subsequent re-organization and re-aggregation. It seems likely that the effect of Web 3.0 NFTs on some industries will be as big as the introduction of Web 1.0.
The users are already there, or else getting there quick. Opensea (which is the marketplace for NFTs today) is on a tear and just got a $13 billion valuation.
That said, all the usual pitfalls are still present: NFTs are almost certainly in some massive bubble (again, much like Web 1.0 in 2000). And the complexity lends itself to huge information asymmetries, so scams are everywhere, and yet more economic re-organization is probably in our future.
At least for now, it seems like the way to participate in the medium- to long-term of the wave may have little to do with collectibles and much more to do with new blockchain-backed contenders using the tech’s fundamentals to challenge incumbents.
I think there’s a distinction to be drawn here between:
NFTs as an concept. The possibility that something like NFTs ends up existing and being a substantial market segment.
NFTs that currently exist. The possibility that current NFTs will be worth a lot of money in the future.
Even if NFTs succeed in sense #1 (with NFTs providing some form of decentralized ownership for large markets and lots of value being embedded in NFTs), that doesn’t necessarily imply that they will succeed in sense #2 (with currently-existing NFTs becoming worth a lot and people who hold them making a lot of money).
This is my thought exactly. The digital Art NFTs that are selling now or a distraction.
NFTs are a decentralized receipt system which is totally awesome and which you cannot get rich off by collecting receipts.
I think maybe I’m a little less confused now?
I’m still confused about why that is “totally awesome”.
So there are lots of situations where receipts are pretty important, but increasingly there is a push to have them be digitized, either because it’s just more efficient or the asset itself is digital. For example, suppose you buy a movie through your smart TV.
The problem is these digital receipts tend to either be just downloadable PDFs—easily forged and effectively meaningless—or they’re central databases, which are under the control of the party that owns the database. They can be revoked, lost, made obsolete, etc. Suppose the company that holds my downloaded movie purchase goes bankrupt. Now if I torrent that movie I’m not really breaking the law, or am I? How would I prove that?
A decentralized blockchain system would solve those problems and could be used for proving all kinds of things. “Send us a copy of your diploma”—“here, it’s an NFT”, “send us your invoice to prove you are in warranty”, “here’s the NFT”, “Can you sell me your old copy of Civilization 4?” “Yes, I’ll transfer the NFT to you for $40″.
The potential to store trusted receipts has so many useful applications, we’re just not quite there yet in terms of building it.
I’m confused as to how NFTs ‘really’ solve any of the problems you mention (or similar ones I can imagine).
My understanding is that ‘blockchains’ are, today, pretty centralized, especially effectively (i.e. in practical ways that matter). Any particular ‘blockchain’ also seems possibly ‘lost’ (e.g. abandoned), ‘made obsolete’, etc.. Isn’t there any inherent and inevitable ‘social expense’ that has to be continually made anyways?
I don’t think any current ‘movie purchases’ work like what you describe. It certainly seems like it matters as to whether any ‘movie company’ would be willing to offer movies for sales on the terms you seem to be implicitly assuming, e.g. be able to download a movie an unlimited number of times. Does – today – reasonable evidence of having purchased a movie, e.g. as a DVD or Blu-ray disc, serve as protection or a legal defense to later downloading it thru some other means? I don’t think it does. I’m very skeptical that the companies that sell products like this would willingly offer terms like what you seem to have in mind, e.g. ‘Pay us and then just torrent the movie whenever you want!’.
This is the most interesting example, but I’m skeptical that even it would work that great. (I do admit I’m ignorant of even the gross technical details about how the example would work ’mechanically.)
Is this resilient in the face of, e.g. losing access to whatever ‘wallet’ the NFT is associated with (on either ‘side’)? How would the person or organization requesting someone’s diploma verify that the NFT was issued by the relevant college/university?
Surely some kind of centralized database is still required, right? Wouldn’t the entity requesting the invoice need to have some kind of ‘whitelist’ of entities that are approved to issue these NFTs?
I’m not sure that this meaningfully improves anything. Without some kind of ‘DRM’ (which mostly doesn’t, and probably can’t work generally anyways), this just seems like a more convoluted way to ‘paywall’ a download endpoint.
Not really. The blockchains themselves are decentralized, but the applications built on top of them are centralized. To my buying a movie example, suppose I have an app on my SmartTV called “stream1” that lets me buy movies and register them via NFT (cool). I would prefer that to buying them from say Amazon Prime which did not have NFTs, even if it cost an extra dollar or two. 5 years later, stream1 shuts down. I’m not saying I would actually go torrent the movie. What might happen instead is that a new company starts up called “stream2″ which allows you to play movies you’ve bought in the blockchain, as well as buy new movies. Or maybe Amazon prime has added the feature by then and I can connect my licenses to their service. This is equivalent to a new company coming out that sell Blu-ray players. You already own the Blu-rays, they’re offering you a way to play them.
But this is precisely what we had before the internet. We used to have physical media that (theoretically) could be copied to multiple devices. You weren’t legally allowed to, but the technology left you in control. I know gamers as a group want this control back after getting shafted by video game companies.
No not at all. The blockchain can do this. The blockchain contains information about who minted it. So a hiring company—say, Google—would know which wallet MIT used for minting their diplomas. If it came from that wallet, then it’s legit. In the long run, applications could create a more user-friendly layer. So you paste in the relevant info to your job application, and Google’s HR database automatically verifies it on the blockchain.
Definitely it seems like a paywall because it is a paywall. Just a more balanced one. As it is, any time you join any kind of DRM or paywall scheme, you’re completely at the mercy of the content host, who can remove your rights to all the stuff you “bought” at any time.
I think this is where there’s been a beanie-baby craze with this stuff on the supply side—where some parties are eager to just sell more because there’s a new channel. When in fact, what we have is a better channel, and we need to move old sales onto the new channel.
Sure, existing markets won’t like it—because they lose control. But it’s comparable to how Netflix disrupted Cable TV. People liked the way Netflix served the content better, and cut their cables. Then they became too big to ignore, and all the major content owners got on board. I could see this happening with NFTs too. If I went to buy some digital content and there were two competing marketplaces—I would 100% choose the one that let me really own my purchase via NFT, instead of one that requires me to just trust them to keep it for me.
Trust powers commerce, and I really believe NFT marketplaces implemented properly will drive more people to buy with confidence.
The process would be the same as if I lost my Physical diploma. Call the university and they have to mint an identical one for me, at a cost to me.
Why would the relevant companies, i.e. movie studios, do that? They could do that now if they wanted to.
But you seem to be claiming that the possibility of future parties ‘honoring’ NFTs, and NFTs issued by other parties, is exciting. I still don’t understand why that’s plausible. If anything, the visibility/legibility of NFTs makes me think this is MUCH less likely.
The blockchain can’t itself verify to anyone that the information it contains is true or accurate.
I can imagine that Google would have alternate channels by which they could verify that a certain wallet is (or was) used by MIT for “minting their diplomas”, but that has to be outside the blockchain (and thus subject to all of the standard security ‘hacks’).
But you seem to be assuming that companies/organizations will voluntarily ‘honor’ past purchases when that seems to be extremely unlikely to me. Why would future content hosts pay to provide access to something (e.g. bandwidth, hosting) that people purchased from someone else? I can imagine someone doing that as some kind of ‘limited promotion’ but I don’t understand why everyone would do that (e.g. by default).
I was thinking primarily about the ‘other side’, e.g. the university losing access to their wallet (or access to it otherwise being compromised, e.g. fraudulent diplomas being “minted”).
On the anti-regulation aspect, my subjective reading of the web3 community is that very few of its members hold strong anti-regulation stances whereas most just want less bureaucracy. For example, a16z, an investor in OpenSea and a number of other web3 companies, writes this on their policy page:
It’s interesting that you bring up the dot-com bubble angle. I can’t remember where I read it, but I found a stance that basically said the bubble was good because it injected a massive amount of money into the web market, so after the bubble burst, there were a lot of people trained to build web apps, people that could be hired for less-than-crazy amounts of money, which in turn led to the slow, steady growth of the web in the second half of the 00′s. Kind of like priming the pump.
I like to think that this may be one outcome of what’s happening with web3--that the buildup of talent will lead to building high-utility blockchain-based applications, especially in the coordination problem space.
Your regular reminder that whether something is a ponzi scheme can be independent of the question of whether you should try to make money from it. If you think you can predict it well enough, by all means try to make money off the ponzi scheme. (Or if not, maybe don’t.)